Gartner (IT) Eugene A. Hall on Q2 2016 Results - Earnings Call Transcript

| About: Gartner Inc. (IT)

Gartner, Inc. (NYSE:IT)

Q2 2016 Earnings Call

August 04, 2016 8:30 am ET

Executives

Sherief Hassan Bakr - Group Vice President-Investor Relations

Eugene A. Hall - Chief Executive Officer & Director

Craig W. Safian - Chief Financial Officer & Senior Vice President

Analysts

Timothy J. McHugh - William Blair & Co. LLC

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Gunnar Hansen - RBC Capital Markets LLC

Manav Patnaik - Barclays Capital, Inc.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Anjaneya K. Singh - Credit Suisse Securities (NYSE:USA) LLC (Broker)

Joseph Foresi - Cantor Fitzgerald Securities

Henry Sou Chien - BMO Capital Markets (United States)

Operator

Good morning, ladies and gentlemen, and welcome to Gartner's Earnings Conference Call for the Second Quarter of 2016. A replay of this call will be available through September 4, 2016. The replay can be accessed by dialing 888-286-8010 for domestic calls and 617-801-6888 for international calls and by entering passcode 21946131. This call is being simultaneously webcast, and will be archived on Gartner's website at www.gartner.com for approximately 30 days.

I will now turn the conference over to Sherief Bakr, Gartner's Group Vice President of Investor Relations, for opening remarks and introductions. Please go ahead, sir.

Sherief Hassan Bakr - Group Vice President-Investor Relations

Thank you, Sue, and good morning everyone. Welcome to Gartner's second quarter 2016 earnings conference call. With me today in Stanford is our Chief Executive Officer, Gene Hall; and our Chief Financial Officer, Craig Safian.

This call includes a discussion of Q2 2016 financial results as disclosed in today's press release, as well as our outlook for 2016. After our prepared remarks, you'll have an opportunity to ask questions. I'd like to remind everyone that the press release is available on our website, investor.gartner.com.

Before we begin, I'd like to remind you that certain statements made in this call may constitute forward-looking statements. Forward-looking statements can vary materially from actual results and are subject to a number of risks and uncertainties, including those contained in the company's 2015 Annual Report on Form 10-K and 2016 Quarterly Report on Form 10-Q, as well as in other filings with the SEC. I'd encourage all of you to review the risk factors listed in these documents.

With that, I'd like to hand the call over to Gartner's Chief Executive Officer, Gene Hall.

Eugene A. Hall - Chief Executive Officer & Director

Good morning, everyone, and welcome to our quarterly earnings call. Q2 was a robust quarter with strong performances across our business. As on prior calls, I'll review our key operating metrics on an FX neutral basis.

We do business in more than 90 countries around the world. And with ongoing currency fluctuations, that's the best way to understand the underlying health of our business. For the second quarter of 2016, total company revenues grew 12% and we continue to see robust demand for our products and services.

Research, which is our largest and most profitable segment, achieved 17% revenue growth over the same quarter last year. These results were driven by double-digit contract value growth and contributions from our recent acquisitions. Our contact value grew 13% with double-digit growth in every region, across every client size and in, virtually, every industry. Client retention and wallet retention were strong at 83% and 104% respectively, while down modestly from our recent all-time highs.

Our Consulting segment deepens relationships with our largest clients. And for Q2, our Consulting business achieved 6% revenue growth with utilization up 1-point over the same quarter last year. Backlog, which is a leading indicator of future revenue growth for this business segment, grew 15% over this time last year.

Our Events segment continues to drive strong growth by extending our brand. For the second quarter 2016, Event revenues were up 16% on a same events basis. We hosted more than 15,000 attendees across 25 events that we held in the quarter.

Our results reflect the tremendous value we deliver to our clients. Technology is critical for every enterprise around the world. Every enterprise has cybersecurity risks. Every enterprise is worried about technology disruption. And technology is the key to fueling cost reduction, whether enterprise is funding new growth initiatives or improving margins.

Enterprises know they need help. And Gartner is the best and most cost-effective source for that help. Our clients rely on us for independent, objective, fact-based insights for making critical technology decisions. Our services deliver tremendous value, and in most cases pay back many times over.

There're a number of factors in the global economy today that impact our clients. Economic growth has slowed in countries around the world. Oil and other commodity prices have fallen dramatically. Exchange rates are at levels that challenge U.S. exporters and challenge non-U.S. importers. And most recently, there's Brexit. As a result of these factors, we see a higher proportion of our clients with financial challenges compared to the past few years. In the U.S., the S&P 500 is having its fourth consecutive quarter of negative earnings growth. In Europe, the S&P 350 is expected to have negative earnings growth this year.

In any of our markets, we always have clients who are doing great, clients who are doing okay and clients who are in economic distress. We know how to be successful with all clients, whether they're thriving or in financial distress, which is why we've consistently delivered double-digit growth in every geography, in virtually every industry and across every client site segment.

However, when clients are in distress, decisions like those can get extended as they scrutinize every expense. Because of the pervasive criticality of technology and the incredibly strong value we deliver, we win with these clients. The decisions like those can take longer, which has led to a modest reduction in our growth rate. With an enterprise that's thriving or facing economic challenges, Gartner is the insight and advise our clients need to achieve the success in their mission-critical priorities.

So summarizing, we had a very robust Q2 with strong performances across our business. Our client base is highly diversified with more than 10,000 client enterprises, in every size from the largest in the world to the smallest, and more than 90 countries and across every industry. We had double-digit contract value growth in all geographies, all client sizes and virtually all industries.

We've a huge untapped market opportunity. We've robust demand for offerings and our pipeline is strong, and we're not standing still. We attract the best talent in the industry. We continue to invest in innovations to improve our content, products, hiring, training and tools to drive continued improvement in our operational effectiveness. We're committed to enhancing shareholder value through investment in our business, strategic acquisitions and share repurchases. Our 2016 and long-term outlook is strong.

And with that, I'll hand the call over to Craig.

Craig W. Safian - Chief Financial Officer & Senior Vice President

Thank you, Gene, and good morning, everyone. Gartner's second quarter performance continues our long-term trend of double-digit growth. Despite challenges in the economic environment, we see robust demand for our products and services, and our sales pipeline is strong.

The combination of the tremendous value we provide to our clients around the world, the investments we're making to capture our vast market opportunity and our exceptional business model allows us to consistently deliver double-digit revenue, earnings and free cash flow growth. Our first half performance, combined with our expectations for the balance of the year, indicate that we are well on track to continue that trend for the full-year 2016.

On an FX neutral basis, our year-on-year financial performance for the second quarter 2016 included: contract value growth of 13% and Research revenue growth of 17%; Events revenue growth of 16% on a same events basis; Consulting revenue growth of 6% with backlog growth of 15%; normalized EBITDA growth of 5% or 14% when adjusted for the shift in the timing of events; and diluted EPS, excluding acquisition adjustments, of $0.71 per share. This compares to $0.65 per share in the second quarter of 2015, and our guidance range of $0.66 per share to $0.70 per share.

In addition, our exceptional business model and focus on cash flow continues to create a consistently high level of free cash flow conversion. On a rolling four-quarter basis, our free cash flow conversion was 142% of normalized net income.

For the first half of the year, which normalizes for the calendar shift in events, our year-over-year FX-neutral performance highlights are as follows. Total revenue growth of 16%; Research revenue growth of 18%; Consulting revenue growth of 9%; Events revenue growth of 14%; normalized EBITDA growth of 16%; and diluted earnings per share, excluding acquisition adjustments, of $1.32 per share. This compares to $1.02 per share in the first half of 2015, an increase of 29% on a reported basis.

I'll now discuss our second quarter business segment performance in-depth, and then turn to our balance sheet and cash flow dynamics. I will then close with remarks on our guidance for Q3 and outlook for the full year. We will then be happy to take your questions.

Beginning with Research; Research revenue grew 16% on an as-reported basis and 17% on an FX-neutral basis in the second quarter. Excluding the impact of our newest acquisitions and FX, Research revenues were up organically by over 12%. Our recently acquired businesses continue to perform strongly.

The gross contribution margin for Research was 70% for the same level compared to the second quarter of 2015. All of our other Research business metrics remained strong. Total contract value was $1.754 billion as of the end of Q2, FX-neutral growth of 13% versus the prior year. For reference and comparison, our Q2 2015 total contract value, at current year FX rates, was $1.549 billion.

We have a highly diversified business. We serve clients in more than 90 countries. Our clients operate in every industry vertical. And we serve the largest enterprises in the world, down to the smallest businesses. This diversified client base is a strength, as it helps us to mitigate against problems in any one region, any one industry or any one size of client. Consistent with this, our growth in contract value continues to be broad based. Every region, every client size and virtually every industry segment grew at double-digit rates.

As Gene mentioned, client retention was 83% for Q2, down 2 points from the second quarter of 2015. Wallet retention ended at 104% for the quarter, also down 2 points year-on-year. As Gene mentioned earlier, we are seeing a higher proportion of clients experiencing financial challenges. These challenges impact our retention and productivity metrics.

For example, decision cycles can lengthen. And if those decisions stretch over a quarter, it can impact retention and productivity. That said, we still offer our clients great value and know how to operate successfully, whether our clients are in growth mode or are facing challenges.

New business increased 11% year-on-year in Q2. The new business mix is consistent with prior quarters and remains balanced between sales and new clients, and sales of additional services and upgrades to existing clients. And as always, we continue to benefit from our consistent price increases and discipline around pricing.

Our new business growth reflects our success in penetrating our vast market opportunity with both new and existing client enterprises. We ended the second quarter with 10,477 enterprise clients, up 5% compared to Q2 2015. The average spend for enterprise also continues to grow. It now stands at $167,000 per enterprise, up 7% versus prior year on an FX-neutral basis. This increase in average spend reflects our ability to drive CV growth through both new and existing enterprises.

Turning to sales productivity. As we have detailed in the past, we calculate sales productivity as the net contract value increase, what we call NCVI, per account executive. We look at it on a rolling four-quarter basis to eliminate seasonality, and we use opening sales head count as the period denominator.

Over the last 12 months, we grew our contract value by $205 million in FX-neutral terms. Using our Q2 2015 ending sales head count of 2,070 as our beginning of period denominator yields NCVI per AE of $98,000 on a rolling four-quarter basis, or a 14% decline over the second quarter of last year when the comparable figure was $114,000 per account executive at constant currency rates.

As always, we remain highly focused on improving our sales productivity and remain confident that the initiatives we have implemented to drive productivity will positively impact our results over the long-term.

Consistent with this, our strategic priority continues to be on investing to capture the vast market opportunity ahead of us and to drive long-term earnings and cash flow growth for our shareholders. We continually evaluate and adjust the pace of these investments, taking a highly analytical approach to how and where we allocate sales resources, all the way down to the individual team level. We do not take a one-size-fits-all approach.

For example, if we are seeing strong CV growth and good productivity trends in a team or region, then we would plan to increase head count faster than the average in those areas. Similarly, if we were to see decelerating CV growth and declining productivity metrics, we would slow head count growth. We will continue to make operational adjustments where needed and report back to you on our progress.

To sum-up, we delivered a solid quarter in Research with 13% contract value growth and strong growth from our most recent acquisitions. While sales productivity declined in the quarter, we are confident that the productivity initiatives we have in place will positively impact contract value growth in 2016 and ultimately Research revenue growth over the long-term.

Moving to Events. On a same-event and FX-neutral basis, Events revenues increased 16% year-on-year in Q2. As noted last quarter, we moved three larger events that occurred in Q2 2015 into the first quarter of 2016, which impacted the reported results in both Q1 and Q2 of this year. In the second quarter, we held 25 events with 15,451 attendees, compared to 26 events and 17,107 attendees in the second quarter of 2015. On a same-event basis, we had a 5% increase in attendees. Events Q2 gross contribution margin was 54%, up slightly compared to the lighter year-ago quarter. As I mentioned earlier, Events revenue increased by 14% on an FX-neutral basis in the first half of 2016.

Consulting had a strong quarter, generating a 6% year-on-year FX-neutral increase in revenues. The labor-based business was up 10% versus Q2 of last year on an FX-neutral basis, with broad-based growth. The contract optimization practice declined for Q2 versus 2015, but has showed growth on a year-to-date basis.

The underlying operating metrics of our Consulting business remain strong. On the labor-based side, global head count of 626 was up 11% from the year-ago quarter, and second quarter annualized revenue per billable head count ended at $408,000, which was approximately flat year-on-year on an FX-neutral basis.

Our ongoing investment in managing partners continues to drive demand for our services, and we had 112 managing partners at the end of Q2, a 12% increase over the year-ago quarter. Related to this, backlog, the key leading indicator of future revenue growth for our Consulting business, ended the quarter at $109 million, up 15% year-on-year on an FX-neutral basis. This represents over four months of forward backlog.

Moving down the income statement. SG&A increased by 14% year-over-year in the second quarter, primarily driven by the growth in our sales force. As of the end of Q2, we had 2,297 direct quota-bearing sales associates, an increase of 227 or 11% from a year ago. At June 30, we had a large number of new sales associates who are still in training, and thus not in the final count. If we normalize for the timing of these hires, our year-on-year sales head count growth was 14% for the quarter.

Moving on to EBITDA and earnings; normalized EBITDA was $118 million in the second quarter, up 7% year-on-year on a reported basis and up 5% on an FX-neutral basis. Excluding the shift in events I mentioned earlier, normalized EBITDA would have been up approximately 14% in the quarter. On a year-to-date basis, normalized EBITDA is up 16% versus the prior year on both a reported and FX-neutral basis.

Moving down the income statement; depreciation, amortization and acquisition and integration charges all increased year-over-year reflecting higher capital spending to support our growth as well as the impact of our recent acquisitions. Net interest expense was $7 million in Q2, reflecting our increased borrowing. Our GAAP tax rate for the quarter was 37.9%, which is higher than our full-year GAAP tax rate guidance of approximately 36% due to Q2 timing of tax costs. Adjusting for acquisition charges, our normalized tax rate for the quarter was 35.1%, which is in line with our full-year normalized tax rate guidance of approximately 35%.

GAAP diluted earnings per share was $0.57 in Q2. Our GAAP EPS included roughly $0.14 worth of acquisition and integration charges. EPS, excluding acquisition and integration charges, was $0.71 per share in Q2, up 9% versus Q2 of 2015. On a year-to-date basis, EPS excluding acquisition and integration charges is up 29% year-over-year.

Turning now to cash; for Q2, operating cash flow was $145 million, approximately flat on a year-on-year basis. We define free cash flow as operating cash flow, less capital expenditures with cash acquisition and integration payments added back. In the second quarter, free cash flow was $127 million compared to $132 million in Q2 2015.

Managing our business to generate strong cash flow is one of our top priorities. Year-to-date free cash flow was impacted by three primary factors. First, the modest deceleration of our CV growth rate. Second, the timing of bookings across all of our businesses. And third, modestly higher capital expenditures to support the growth of the business. Our full-year outlook still shows free cash flow growth of 11% to 19%.

Consistent with the negative working capital dynamics that are a key characteristic of our subscription-based business model, we continue to generate free cash flow well in excess of net income on a rolling four-quarter basis. At the end of Q2, this equated to a rolling four-quarter free cash flow of $320 million. This represents a net income to free cash flow conversion of 142%.

Strategic acquisitions and share repurchases continued to be the primary uses of our free cash flow and available capital. Our number one priority remains executing on value-creating, acquisition opportunities and our M&A pipeline remains active.

At the end of the second quarter, we announced and closed the acquisition of SCM World, a leading cross-industry peer network and learning community providing subscription-based research and conferences for supply chain executives, spending $29 million in Q2. As you'll see in our 10-Q, there are other contingent payments associated with this deal based upon employment and performance criteria. We were able to use our overseas cash to fund this acquisition.

During the second quarter, we repurchased $7 million worth of our shares. On a year-to-date basis, we've repurchased 52 million of shares. As of June 30, we had approximately $1.1 billion available under our share repurchase authorization.

We ended the quarter with a strong balance sheet, cash position and enhanced liquidity profile. As of June 30, we had gross debt of $835 million. When combined with our cash balance of $445 million, it represents a net debt position of $390 million or about 0.9 times normalized EBITDA.

In June, we closed on a new $1.8 billion secured credit facility consisting of a $600 million term loan and a $1.2 billion revolver. As we assessed our projected growth, our potential future needs as well as the attractiveness of the bank markets, we decided to take the opportunity to expand and extend our credit facility.

As of June 30, we have an additional $966 million of revolver capacity. That and our ongoing free cash flow generation gives us ample liquidity to continue to grow our business and execute initiatives that drive shareholder value.

Before discussing our guidance, I did want to mention Brexit, as I know that many of you've been asking questions related to it and our exposure in the UK.

We generated approximately 7% of our revenues in the UK. More importantly and as I mentioned earlier, we know how to operate and execute in times of uncertainty. By staying focused on our customers' mission-critical priorities, we're confident that we can continue to provide value, whether our clients are thriving or under financial stress.

Turning now to guidance. Except for some modest changes to reflect the impact of our most recent acquisition, our guidance is unchanged from May. If you recall, we raised our guidance in May and our Q2 performance is consistent with that outlook.

All of the guidance information is contained in our press release, so I'll only focus on the highlights and the items that changed.

Our 2016 guidance still expects total revenues of $2.405 billion to $2.465 billion. This is FX-neutral growth of 13% to 15%. We continue to expect to deliver between $450 million and $480 million of normalized EBITDA, or 11% to 19% growth on an FX-neutral basis.

To account for additional amortization and acquisition and integration charges from the SCM World deal, we now expect approximately $0.05 more of acquisition and integration charges in 2016. As a result, we are updating our GAAP EPS guidance and now expect $2.22 per share to $2.44 per share in 2016. This includes $0.45 per share of acquisition-related charges. Excluding acquisition and integration charges, our guidance for EPS remains at $2.67 per share to $2.89 per share in 2016. This represents FX-neutral growth of approximately 13% to 22%.

There are no other changes to our outlook for the full-year 2016.

For the third quarter of 2016, we expect GAAP EPS of $0.36 per share to $0.40 per share, including $0.11 per share of acquisition and integration charges. This yields EPS excluding acquisition and integration charges of $0.47 per share to $0.51 per share. Q3 is historically one of our smallest quarters, and that is the case again in 2016.

In summary, Gartner delivered another very strong quarter in Q2 with all three of our businesses performing well. Despite some challenges in the economic environment, demand for our products and services continues to be robust and our sales pipeline is strong. We continue to provide value to our clients and are in a great position to help our clients with our most important technology, supply chain and digital marketing initiatives, whether they are in growth mode or are facing challenges.

Our strategic priority continues to be on investing organically and through value enhancing initiatives to capture the vast market opportunity ahead of us, while also returning capital to shareholders. Our recent acquisitions and execution of our ongoing share repurchase program is consistent with this.

We remain highly focused on driving sales force productivity and we're confident that the initiatives we've implemented to drive productivity will positively impact the results over the long-term.

We had a very strong first half of 2016, and our full-year 2016 outlook is for double-digit growth in revenue, earnings and cash flow. And finally, we continue to leverage our powerful business model, which consistently delivers free cash flow well in excess of net income.

With that, I'll turn the call back over to the operator, and we'll be happy to take your questions. Operator?

Question-and-Answer Session

Operator

Thank you. And your first question comes from the line of Timothy McHugh from William Blair. Please proceed.

Timothy J. McHugh - William Blair & Co. LLC

Thank you. I guess, first, just wanted to ask on your comment about the little bit longer sales cycle. I guess, it's understandable in this environment, but can you maybe elaborate, I guess, I know you grew double digits in every kind of region and client size, but were there areas of the world where you saw this more and less, and I guess was it any more pronounced later in the quarter surrounding Brexit and some of that volatility than, I guess, earlier in the quarter?

Eugene A. Hall - Chief Executive Officer & Director

Right. Hey, Tim. It's Gene. So, to get to the last part first, we didn't see in the quarter anything we could directly trace to Brexit on anything. So, within Q2, I'd say, we couldn't pick up any direct impact of Brexit.

With regard to sort of elaborate a little, if you think about selling – I'll use Brazil as an example. If you're selling to an enterprise in Brazil, whether it's public sector or private sector, the economy is just terrible. It's shrinking. They have a lot of problems. And they still buy. We're actually growing in Brazil still, but it's a lot lower than it was before. And so, what happens is, client may want to take – this happens in public sector frequently, client will want to renew because the government revenues are down so much, there's a lot of scrutiny and sometimes that renewal will extend for, call it, three months longer than we would have normally had wherever it is right on time. That's an example of what the kind of things going on. And it's in the areas you'd expect, which is like where oil and gas has been really affected. Again, in the oil and gas by the way, in aggregate, we were growing. In Brazil, we were growing. In fact, it's a lot slower growth than it used to be. And that's kind of an example of the extended decision-making cycle. So, it's exactly we'd expected.

Timothy J. McHugh - William Blair & Co. LLC

Are you surprised though, it was kind of a volatile world in the first quarter as well. And I guess, so, what feels different, I guess, in 2Q than 1Q that you're highlighting it a little bit more?

Eugene A. Hall - Chief Executive Officer & Director

I think it's not that there is a dramatic change between first quarter and second quarter. I think that it's kind of an incremental change where these – when things get bad, companies hope that they're going to get better. And when they stay better – again, I'll use Brazil as an example, when it becomes clearer and clearer that there's problems, incrementally things get a little worse. By the way, my sense in Brazil is it's bottomed out, but I do think that it was a little worse in Q2 than it was in Q1, and Q1 was a little worse than it was in Q4. And so that's just an example.

Timothy J. McHugh - William Blair & Co. LLC

Okay. Thanks. And, Craig, just real quick numbers on. Can you give us any sense for the contract value or revenue for SCM?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Hey, Tim. Good morning. Yeah. It's small. It's a relatively small acquisition as you've seen from the purchase price. It doesn't contribute all that much to the overall. And we typically don't break out the contract value from small businesses or from small acquisitions, but suffice it to say, we think it's a great deal for us. It really helps us and enhances our supply chain business selling into the key executives from a supply chain perspective, but relatively small from a contract value perspective.

Timothy J. McHugh - William Blair & Co. LLC

Okay. Thanks.

Operator

Thank you. And your next question comes from the line of Jeff Meuler from Baird. Please proceed.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Yeah. Thank you. Good morning. I guess, just given that you cite a lot of the research metrics on a rolling LTM basis, but given all of the commentary in the prepared remarks, just to confirm, it does sound like if you just look at the quarterly metrics, things are trending, I guess, a little bit worse or a little bit slower growth in Q2 just on a quarterly metric basis than they were three quarters, four quarters ago. Is that an accurate interpretation?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah, Jeff. That's 100% accurate. And, again, I think a lot of it relates to what Gene just described both in his prepared remarks and in the Q&A, as the sales cycles lengthen and things crossover quarters, as I've described. We will often take down business that will impact the renewal rate. We stay in touch with the client. The client still really needs our value. We win back that business over subsequent months and quarters, but your assertion is correct that Q2 you would see a slowdown in the contract value growth rate as well as the retention measures.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Okay.

Eugene A. Hall - Chief Executive Officer & Director

Yeah.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Good ahead, Gene.

Eugene A. Hall - Chief Executive Officer & Director

I'm sorry. Go ahead, Jeff.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

No. Please add what you were going to.

Eugene A. Hall - Chief Executive Officer & Director

So, like I said, keep in mind, again, we had great double-digit contract value growth. And so, I don't want to overplay the point which is, we have tremendous market opportunity. Clients love our products. We had great double-digit growth. I mentioned our retention metric was down a little bit, but it's still at great – you compare to any metric externally, it's terrific measure and it's down slightly from our all-time high. So, actually, we're seeing great demand for our products. Just, as you said, a little different than it was a year ago.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Okay.

Eugene A. Hall - Chief Executive Officer & Director

In the places you'd expect.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Understood. And then on capital deployment, asking this question in the context of slower first half share repurchases coupled with the increased credit line. Anything that should be read into putting those two things together in terms of appetite for a larger deal? Or is there something about the credit facility that will help facilitate more aggressive share repurchases that was an obstacle in the first half or anything like that?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Hey, Jeff. It's Craig. I think when we look at capital deployment, there's really no change to how we think about the approach. We're, as always, we remain very focused on ensuring that we deploy our cash flow and our balance sheet flexibility and our capital to drive value for shareholders. We always talk about, and this has not changed, we have two priorities.

Our number one priority is shareholder value enhancing strategic M&A. And we've proven over the last two years, two-and-a-half years that we've been able to do that and get really great properties and bring them into Gartner and drive really great growth and really great value for our shareholders. In absence of those value-enhancing M&A, we still believe that return of capital to shareholders through share repurchase program is a great way to do that. And those remain the two top priorities. But number one is still that value-enhancing strategic M&A.

From a credit facility perspective, it's one of those things where when you look at our growth and where we're going and making sure that we have access to capital to do the value-enhancing things we want to do, we looked at the markets and we just wanted to make sure we took advantage of being able to upsize the credit facility, push out the term at extraordinarily attractive rate. So, it's really a combination of we're growing and we want to make sure we have the right size credit facility, and then also being strategically opportunistic around making sure we locked in at very attractive pricing.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Okay. And then just final one from me, can you remind us how you calculate retention and, specifically, I'm wondering, is there some sort of adjustment made for when a client drops out for a two-months or three-months period, or is it just a pure mathematical calculation with no adjustment made for factors like that? Thank you.

Craig W. Safian - Chief Financial Officer & Senior Vice President

It varies, Jeff. It's kind of situational depending on the client situation. But generally speaking, if we take the business down, so if the client does not renew on time, generally speaking that will come out of the retention in that given quarter. And then as we work it back, it goes back into the contract value base when they resume their services.

Jeff P. Meuler - Robert W. Baird & Co., Inc. (Broker)

Okay. Thanks, guys.

Operator

Thank you. And your next question comes from the line of Gary Bisbee from RBC Capital Markets. Please proceed.

Gunnar Hansen - RBC Capital Markets LLC

Hey, guys. Good morning. This is Gunnar Hansen in for Gary. Gene, you mentioned just some in the post Brexit comment that 2Q wasn't impacted. Now that we're kind of a month, little over a month beyond the vote, has there been any incremental kind of headwind or slowness there in that region that you want to mention?

Eugene A. Hall - Chief Executive Officer & Director

Well, I'd say, it's too early to tell. So, again, it's too early to tell.

Gunnar Hansen - RBC Capital Markets LLC

Okay. Fair enough. And I guess, Craig, just with the sales force hiring, and obviously, you said that there is a big class, I guess, toward the end of the month in June. Is it still the expectations, I guess, any updated commentary on the guidance for the sales head count for the year? It seems like that it is likely to be a touch below kind of the 15% that you guys were guiding for earlier on. Is that fair?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah. Hey, Gunnar. Good morning. We're still targeting in that 15% range, give or take. As I mentioned, if you normalize for the timing of that class, we're at 14%. We were at 16% in Q1 and 16% for full year last year. So, based on everything we're looking at, and again, as I mentioned, we are looking at the growth at a team by team level, but based on everything we're looking at now, we would expect to be in that 15% range.

Gunnar Hansen - RBC Capital Markets LLC

Okay. And then just last one, on a positive note, I'll move away from some of the other challenged sectors, but any regions or sectors or industries that you guys want to highlight that had particular strength in the quarter? Maybe something along the lines of productivity has improved and where you are making incremental additions to the sales force there?

Eugene A. Hall - Chief Executive Officer & Director

So, it's Gene. Yeah, we have lots of areas that are doing well. First, if you look at like Asia is doing well, very well for us sort of – not every country in Asia, but Asia overall is doing very well for us. A lot of the emerging markets are doing very well for us. If you look within the U.S., there're certain industries that are doing very well. I won't break it out, but there're certain industries that are doing very well. In Europe, again, there're certain countries that are doing well.

Gunnar Hansen - RBC Capital Markets LLC

Okay. Fair enough. Thanks.

Operator

Thank you. And your next question comes from the line of Manav Patnaik from Barclays. Please go ahead.

Manav Patnaik - Barclays Capital, Inc.

Thank you. Good morning, gentlemen. So, I think, obviously, the deceleration in some of the markets and so forth is probably not surprising given the macro challenges out there. But I guess going forward, is the way we should think about it is, given all the positive commentary you had to say, Gene, and the hiring is still on track for 15% that, irrespective of the deceleration, you guys will still just power on with the 15% sales head count growth even if that impacts productivity?

Eugene A. Hall - Chief Executive Officer & Director

So, where we start from is this. As you know, we have this incredibly large untapped market opportunity. And we approach our businesses long-term, which is, we want to make sure we continue to capture that market opportunity and position ourselves well for double-digit growth every single year.

Having said that, as you know, we also then take that and we look at each individual sales team, we go down to an individual manager level and say, based on the macroeconomic environment they're facing, (39:17) – based on the industry specifics they're facing and based on the bandwidth of that particular manager, can we add capacity there.

So, again, if I looked at – again I'll go back to Brazil, most of our managers in Brazil, we are not adding head count to because they have their hands full dealing with the economic issues there. Again, we're still growing in Brazil. So, I want to make sure I reinforce that. And so, we'd be adding a lot less head count there. It'd be unusual to add a lot in someplace like Brazil. On the other hand, we do have areas that are growing very rapidly like Asia, where we might be growing our head count by as much as 25% on those teams.

And so the 15% is not kind of a 15% target at a kind of macro level. We look at individual teams and say, based on the market condition that team is facing, and based on the capability that manager to take on additional headcounts and additional opportunity, how does that work out? Historically that's worked out kind of around the 15% – between probably 13% to 17% range. And going forward, we're going to do exact same thing. And so, if for some reason we see more teams that are challenged, you might see that toward the lower end of that range and if you see fewer teams toward the higher end of that range, but it's not to set at a macro level, it's set based on bottoms up level that gets us that.

Manav Patnaik - Barclays Capital, Inc.

Okay. Fair enough. Thanks for that color. And then, Craig, did you say that 27% of your revenues is UK or is that Europe as well, because I guess, I think in the past you guys has said all your country exposures mirror GDP and that seemed a little outside. So, maybe you can just help us there?

Eugene A. Hall - Chief Executive Officer & Director

Yeah. I'm sorry, Manav. I said 7%. Nothing in front of the 7%, so, yeah, just 7% of our revenue is in the UK.

Manav Patnaik - Barclays Capital, Inc.

Got it. And then just, since guys are calling out Brazil and oil and gas, any sense of what those exposures are?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah. We've talked about them in the past. I think both are well below 5% of total contract value or total revenue. So, they still represent very small exposures for us. Like I said, they were – before they had those macro challenges, were two very fast-growing areas for us. A little bit of an overlap with oil and gas in Brazil, but they had been very fast growing. And as Gene mentioned, they are continuing to grow, just not at the same rate, but they're growing as previously.

Manav Patnaik - Barclays Capital, Inc.

Got it. Fair enough. Thanks a lot, guys.

Operator

Thank you. And your next question comes from the line of Toni Kaplan, Morgan Stanley. Please proceed.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Good morning. Thanks for taking my questions. Just regarding elongated sales cycle, I just want to make sure I understand correctly, it's just taking a little bit longer to close the sales, but you are still closing the deals, meaning the pipeline isn't dramatically reduced, it's just that it's taking longer to actually close the sales. Is that correct?

Eugene A. Hall - Chief Executive Officer & Director

So, the most of our clients are doing fine. And our sales cycle has not extended or anything. It's just normal business. There are a few areas, like, I picked on Brazil, but like, Brazil oil and gas, where they're under stress. They're looking at every expense, and it does take a little longer. We do, actually, it's very unusual. Even if it's takes longer, we do get the sale. So, yeah, your question is right. We actually do get the sale, but that's just for the – this piece of our business that's under more distress, which isn't most of our business.

And then our pipeline, actually, is way up compared to this time last year. It's way higher than our growth rate. And then, it's purposeful. We purposely have built a very strong pipeline. And so, our pipeline is very, very robust.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Okay. Great. And then, I think you mentioned sort of adjusting head count in different areas when you are seeing either really strong growth or really weak growth, adjusting it up and down. And so, are you doing that continuously? Do you do it sort of once a quarter? How quickly sort of can you adjust that? And, I guess, if you're adjusting up, maybe it takes a little bit of time for people to get to full productivity, but so, how should we think about that?

Eugene A. Hall - Chief Executive Officer & Director

So, we actually have a team that looks at that. We've a territory planning team that looks at that. And they do this on a continuous basis. And so, we make real-time adjustments to the year. So, it's not like we sort of a plan upfront for the year and then it doesn't change based on what's going on that we actually experience. We actually look at it at an ongoing basis and we have a hiring plan each quarter for how many people we want to hire and we make real-time adjustments based on what we're really seeing.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Okay. Great. And just lastly, Events margins actually looked really good this quarter. I know you had the three large events that moved into first quarter. So, I was actually thinking year-over-year margins would be down. Anything to call out in terms of the strength there? Thanks.

Craig W. Safian - Chief Financial Officer & Senior Vice President

Hey, Toni. It's, Craig. We continue to grow that business really well. I think the right way to look at it is, look at it on a first half basis to judge the margins, we're actually up 2 points year-over-year on the year-to-date gross margin. And that's because we're driving really nice growth, organic growth into those events. And when we're able to do that, it does flow through at the margin level.

Toni M. Kaplan - Morgan Stanley & Co. LLC

Thanks a lot. I appreciate it.

Operator

Thank you. And your next question comes from the line of Anj Singh from Credit Suisse. Please go ahead.

Anjaneya K. Singh - Credit Suisse Securities (USA) LLC (Broker)

Hey. Good morning. Thanks for taking my questions. Gene, first off, I wanted to touch on your commentary that a larger portion of your client base is having problems versus a few years ago. So, in broad strokes, would you be able to characterize what that proportion looks like today versus a few years ago?

And would you characterize the pressure you're seeing being higher on the new sales front, or is it more on the retention end? It seems your new business growth continues to be steady in the quarter despite the tough comp from a year ago. So, just wanted to get a better sense of where the pressure may be. Thanks.

Eugene A. Hall - Chief Executive Officer & Director

So, in terms of proportion, I'm not going to break it out in terms of 8%, because it's really a spectrum. It's not kind of they're either in trouble or not. My point is, just, if you look at things like oil and gas or Brazil or the major commodity producers, for example, they're under more stress they were in the past. And that's a different selling environment. Yeah, we do well there, but it's just a different selling environment.

In terms of new versus renewal, the same thing is true, which is, we have a very large market opportunity. We are making sales in all kinds of industries. We already have sales teams, for example, in Brazil. We want them to sell new business. That new business in Brazil is harder just like renewals are harder. If I looked at some of the industries that are not under such stress like, I'll pick healthcare as the example; you see both new business and retention being easier in those industries. So, it's a matter of – where the industries are challenged and it's tough for new business and tough for renewals. Where it's not as much as it's easier.

Again, I want to get back to even in these areas, where I'd characterize it's being tougher, as Craig said, take Brazil, it used to be much higher growth than average in the past. And now it's a bit lower than average. And so that big swing is what's going on. We're still growing there. We still get good retention compared to most of the world, and good do business.

Anjaneya K. Singh - Credit Suisse Securities (USA) LLC (Broker)

Understood. And then with regards to your SCM acquisition, could you talk about, perhaps, how big your supply chain related businesses today? I realize it's probably tiny and you've spoken to, I think, a $4 billion addressable market there, but hoping you can talk a bit about where you're having success today and where you see the low-hanging fruit on that front.

Craig W. Safian - Chief Financial Officer & Senior Vice President

Hey, Anj. Good morning. It's Craig. So, as we've talked about in the past, our supply chain business, which is a great business, it is growing well faster than the average. We think it's a really big market opportunity, and with a combination now of where we had here at Gartner plus the SCM World capabilities and client base, we think it's a really great business on a go-forward basis. We believe that we can continue to grow that business at an accelerated rate. It is as underpenetrated as we are in the overall IT market.

I think that over the long-term, because we can continue to grow our IT business, which is the bulk of it, at such a rapid rate, supply chain will continue to be a small piece of the overall portfolio. But clearly, it's a place where we think we can drive really great growth and drive really amazing value for our clients. It's the same business model as our Research business. It has high renewal rates, the same cash flow dynamics, et cetera. So, we're excited about it, but it still represents a small piece of the portfolio.

Anjaneya K. Singh - Credit Suisse Securities (USA) LLC (Broker)

Okay. Got it. And one final one from me, apologize if I'd missed this, but, you guys have had two quarters of strong backlog growth in Consulting. And I realize you guys increased your guidance last quarter. Is there a reason why you didn't tweak at this quarter in your flattish year-over-year outlook for the second half?

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah. The business continues to perform really well, particularly, on the labor-based side of the business, which is what the backlog supports. What I would say is, the range represents, the relevant range of outcomes as we look at things today, the outlook reflects that. And so, we didn't feel the need to update the guidance based on that. That said, the business continues to perform really, really well. And based on our managing partner investments and based on the backlog, it's really more about the long-term sustainability of the business, and we're investing for that future growth as well.

Anjaneya K. Singh - Credit Suisse Securities (USA) LLC (Broker)

Okay. Thanks a lot.

Operator

Thank you. And your next question comes from the line of Joseph Foresi from Cantor Fitzgerald. Please proceed.

Joseph Foresi - Cantor Fitzgerald Securities

Hi. I was hoping you could help us kind of reconcile some of the metrics around the sales per enterprise. It looks like that number has been moving up pretty consistently, but the number of enterprises that you're adding is kind of decelerating. And, maybe you could just help us understand how you're able to kind of cross-sell into those areas, because it seems it's going actually pretty well and that versus the commentary about the elongated sales cycles.

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah, Joe. Good morning. It's, Craig. So, I think, when we think about our market opportunity, we think about it, it really is in two primary places. One is, obviously, those 100,000 enterprises in our market space that we're currently not doing any business with, and we've made really good progress over the last several years of going from probably 6,000 enterprises to almost or over 10,000 enterprises today.

On top of that, when you look at the average contract value per enterprise, even today at a $167,000 per enterprise that is really low penetration. And as we look across our client base, we know that there are opportunities to drive significantly greater penetration within each of those existing enterprises. And we do that in a variety of ways. We have a tier of services. So, we can upgrade clients once we're in there. We find additional users within the clients and buying centers that we're doing business with, and then we find new buying centers as well within the clients.

On top of that, our supply chain business and our marketing business allows us to even further penetrate those clients. So, again, when we think about that market opportunity, it is the combination of further penetration of existing enterprises, which we think that is an enormous opportunity, plus all that greenfield opportunity with the enterprises we currently don't do business with.

Joseph Foresi - Cantor Fitzgerald Securities

Okay. But do you feel like that's going to be more difficult in the present environment, given the sales cycle elongation? Or do you expect that trend to continue? Have you see any disruption there?

Eugene A. Hall - Chief Executive Officer & Director

So, I don't see it as being more difficult at all. Again, think about our clients in different segments, which is, we have clients that are doing just great, that are, figuratively speaking, not in Brazil. And it's kind of (52:37) and then we have clients that are, figuratively speaking, in Brazil, which are a little tougher. And so I think you wouldn't want to characterize the sales cycle all over are worse. That's not right. There are specific segments in the global economy that are having trouble. We still are growing them, but just not as rapidly as the others.

And so, in terms of continuing to sell more to our existing clients, we're going to do that. We have a lot of that. Typically, it's been two-thirds of our growth actually. It's part of our product strategy. We have products, and we have products for multiple people in an organization. We keep adding more of those products so our salespeople have more to sell, which is why it's typically been two-thirds of our contract value growth.

Joseph Foresi - Cantor Fitzgerald Securities

Got it. And maybe – forgive me if I missed this maybe in the opening remarks, but can you give us some idea of what the impact from currency is? And is there any update for that for given kind of Brexit and some of the recent movements?

Eugene A. Hall - Chief Executive Officer & Director

Sure, Joe. We talked about our results, and what's happening from a foreign exchange perspective is -- and you probably see this in most global companies, we're starting to lap the major strengthening of the U.S. dollar that we saw from back half of 2014 into the first half of 2015. That's why in the quarter you don't see that much of a difference between our reported results and our FX-neutral results. They're pretty tight.

As we look out for the balance of the year, our outlook reflects where exchange rates are as of earlier this week. And as you know, some are going one way and some are going the other way. And so, when we look at where we are with our major exchange rates compared to where we were when we started the year, when we did our initial outlook, and then where we were back in May when we updated our outlook, yeah, the pound is weaker, maybe the yen is a little bit stronger, but at the same time, there are other currencies that are going in both ways. So, the way we look at it right now is we expect back half of the year to look a lot like what we experienced in Q2 from an FX exposure perspective.

Joseph Foresi - Cantor Fitzgerald Securities

Okay. And then a last one for me, and I think just to get away from Brexit for a little bit, sales productivity. Maybe you can just give us an update on your latest thoughts there. And any way we should start thinking about that within an elongated sales cycle over, I guess, the next couple of quarters? Thanks.

Eugene A. Hall - Chief Executive Officer & Director

Sales productivity is one of our top focus areas. We spend a lot of time and effort on it. The things that we're doing, I think, are getting better all the time. And it falls into three main categories: recruiting, which is making sure we hire people that are the best possible fit for Gartner, where we're really focused on having the right analytics to help us make sure we get the right people in the right process.

The second category is in training, where we have, I think, what is one of the best training programs for salespeople in the industry. We continue to improve that training all the time and modify it. It's not static. As an example, one of the things are trained our salespeople on in areas that are a little distressed is how do you deal with those and be very successful in an environment like that, which we know how to do.

And then the last one is in tools where we're very focused on productivity enhancing tools for our salesforce. Technology is changing everything. Technology will allow us to access tools to help our salespeople be more productive as well.

So, we got investments in all three of those areas focused on improving sales productivity, and we feel really good that those are all, over time, are going to have a great impact on our sales productivity.

Joseph Foresi - Cantor Fitzgerald Securities

Thanks.

Operator

Thank you. And your last question comes from the line of Jeff Silber from BMO. Please proceed.

Henry Sou Chien - BMO Capital Markets (United States)

Hey. Good morning. It's Henry Chien for Jeff. Just a quick one for me, thanks. Just looking at your Consulting revenues, can you just talk about what's driving some of these quarter-to-quarter shifts? It looks like backlog has been pretty strong over the past few quarters. I'm just wondering what's driving some of the deceleration in 2Q. Thanks.

Craig W. Safian - Chief Financial Officer & Senior Vice President

Yeah, Henry. Good morning. It's, Craig. I think there's two things going on. So, one is the labor-based business, again, which makes up the bulk of the Consulting revenue, we've seen pretty consistent performance there. And we had strong bookings and strong backlog coming out of Q4. That translated into a strong labor-based revenue quarter in Q1. We also replenished that backlog and entered Q2 with a strong backlog position. I think that led to the strong labor-based growth which I talked about earlier. We were up 10% on our labor-based revenue in Q2 on an FX-neutral basis. I think some of the volatility still comes from the contract optimization business. As I mentioned in my prepared remarks, in Q2 we were actually down on a year-over-year basis in contract optimization. In Q1, we were up a little bit. On a year-to-date basis, we're up modestly on that business, but that's the place that consistently causes some of that volatility.

I think if you peel the onion back a little bit, you'll see our labor-based business has been performing really nicely and really consistently. And again, that goes back to a lot of the investments we've made around managing partners and a lot of the things that the Consulting leadership team has done to make that business more predictable with people, relationships, et cetera. And so, I think, you're starting to see that – or not starting to. You're seeing that flow through in our results. And again, it gives us confidence around Q3 and Q4 given the backlog position we have entering Q3.

Henry Sou Chien - BMO Capital Markets (United States)

Okay. Fair enough. Thank you.

Operator

Ladies and gentlemen, thank you for your question. So, I'd now like to turn the call over to Gene Hall for closing remarks.

Eugene A. Hall - Chief Executive Officer & Director

So, I'd like to summarize the key points of today's call. So, first, we're doing great as a company. We see robust demand for our services and our sales pipeline is incredibly strong. We've a huge untapped market opportunity. We attract the best talent in the industry. We continue to invest in improved recruiting capability training tools to drive sales productivity. We continue to invest in innovations in our content, products, hiring, training and tools to drive continuing improvements in our operational effectiveness.

We're committed to enhancing shareholder value through investing in our business, strategic acquisitions and share repurchases. We're well on track to deliver another year of double-digit growth in contract value, revenue and earnings coupled with strong cash flow conversion. And our long-term outlook remains equally strong.

Thanks for joining us today, and we look forward to updating you again next quarter.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Thank you for joining and have a very good day.

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